ESG investing is growing in the U.S. among institutional investors, with issues such as climate change, gender diversity and weapons distribution garnering significant attention.

Institutional assets invested under environmental, social and governance principles in the U.S. totaled $4.73 trillion at the start of 2016, a 16.9% increase from 2014, according to the U.S. SIF Foundation, Washington, which surveys investors every two years.

While results from the foundation's 2018 survey won't be available until November, a more recent Callan LLC survey found ESG factor incorporation increased among U.S. asset owners in 2018.

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Among the 89 asset owners surveyed in May, 43% percent said they incorporate ESG factors into their investment decisions, up 6 percentage points from 2017 and 21 percentage points from 2013, the first year the survey was conducted.

In another sign of ESG investing's growth in the U.S., a combined 374 U.S. money managers, asset owners and other investment-related organizations had signed onto the United Nations-supported Principles for Responsible Investment as of June 30, up from 303 at the end of June 2017. By joining, signatories agree to implement six voluntary principles for responsible investment into their investment practices.

"More and more investors are really recognizing the merits of ESG as an added dimension to the investment process and a way to broaden your lens on risk and get a better view of the characteristics of your investments, both existing and prospective," said Alex Bernhardt, Seattle-based U.S. responsible investment leader at Mercer.

In Callan's survey, asset owners' top reasons for incorporating ESG were expectations to achieve an improved risk profile and fiduciary responsibility. The most popular implementation approaches cited were considering ESG factors with every investment/manager selection; communicating to investment managers that ESG is important to the plan; and engaging with management, actively voting proxies, and submitting shareholder resolutions.

Climate a top focus

"By far the most urgent and pressing issues," for PRI signatories in the U.S. and around the globe are climate change and environmental issues, said Fiona Reynolds, the network's London-based CEO.

Investors want to know what companies have planned in terms of the transition to a low-carbon economy; how to reduce carbon exposure across their portfolios and obtain climate-related financial data; and understand what opportunities are open to them — for instance, investments in clean technology, Ms. Reynolds said.

In a June interview with Pensions & Investments, Jamie Smith, Denver-based associate director at the
Ernst & Young LLP's Center for Board Matters, said results from this year's U.S. proxy season reinforced that "climate risk is a mainstream investor concern."

Building off momentum from 2017, climate-risk proposals calling on companies to report on the resiliency of their portfolios under the Paris Agreement's 2-degrees scenario received majority support at two companies through June 30, while several similar proposals were withdrawn after the companies committed to enhancing their disclosures. Last year was the first in which climate change proposals received majority support.

Water risks in companies' supply chains and reducing plastic waste are other environmental issues that investors are thinking more about, Ms. Reynolds said, noting that recent extreme weather events and consumer pressure on companies to reduce their plastic packaging are putting a spotlight on these issues.

Social issues gain ground

An "emerging issue" that a number of U.S. signatories and others are thinking about is the social impact of climate change —for instance, the impact of coal mine closures in regions that employ a large number of coal miners, Ms. Reynolds said.

Where it's clear workforces are going to be displaced in the transition to a low-carbon economy, investors are wondering whether companies are going to retrain people for other jobs or what other investments could happen in these towns, she said.

Broadly speaking, social issues are becoming more of a focus for investors, Ms. Reynolds said.

Gender diversity and gender pay practices are two other areas investors are looking at more closely and want additional reporting about, she said.

Gender-lens investing has become very "popular" recently, noted Farzana Hoque, research and communications consultant at the U.S. SIF.

U.S SIF found institutional investors in the U.S. had $397 billion invested in strategies that focus on women's socioeconomic advancement at the beginning of 2016, the only year for which the organization has data.

Ms. Hoque expects that figure has risen since 2016, noting that tailwinds include the heightened publicity of sexual harassment allegations, an increase in the number of gender-lens investing strategies and studies tying gender-focused investing to comparable or higher returns.

The rise of the gig economy and what it means for the future of work and investors is another issue with which PRI signatories are grappling.

"I don't think there are answers to (this) yet," Ms. Reynolds said.

One challenge investors have been running up against has been engaging on workforce management issues at companies that use third-parties to hire their workforce. In some cases, that practice has created ambiguity, making it difficult to determine which company is responsible for workforce procedures, she said.

Very specific to the U.S. are new concerns about the distribution of firearms and the opioid crisis, Ms. Reynolds added.

While many U.S. signatories already have divested from firearms manufacturers, some are still invested in firearms distributors and have been engaging with those companies about the sale of semiautomatic weapons in their stores, she said. Conversations about weapons manufacturing and distribution picked up following the Feb. 14 shooting at Marjory Stoneman Douglas High School in Parkland, Fla., which left 17 dead.

While not a PRI signatory,
Yale University, New Haven, Conn., announced on Aug. 21 that it had adopted a policy prohibiting its $27.2 billion endowment from investing in retail outlets that market and sell assault weapons.

On the governance side, executive compensation, board skills, political spending and transparency, cybersecurity and data privacy are top of mind for investors, Ms. Reynolds said.

The March revelation that data-mining company Cambridge Analytica Ltd. harvested the personal data of about 87 million Facebook Inc. users brought increased attention to the issue of data privacy, ESG experts said.

A barbell distribution

While U.S. asset owners increasingly are incorporating ESG factors into their investment decisions, adoption rates continue to vary dramatically by plan type and size.

On one end of the barbell are large public plans that have been building internal capabilities to address ESG issues in their portfolios, Mr. Bernhardt said. On the other end are family offices and small foundations that embrace mission-related investing or impact investing and are seeking to use their investment dollars to drive environmental and social change. The middle of the barbell is occupied by corporate defined contribution and defined benefit plans, insurance companies and others that "don't have the bandwidth to address ESG," investing, don't feel it's a priority or are unaware of what it is, Mr. Bernhardt said.

Callan's survey also found that corporate plans are the lowest adopters of ESG investing at just 20%, compared with 64% of foundation respondents, 56% of endowments and 39% of public DB and DC plans. Top reasons survey respondents provided for not incorporating ESG were that their plans do not consider factors that are not purely financial and a lack of research tying ESG to outperformance.

Jon Hale, Chicago-based global head of sustainable investing research at Morningstar Inc., believes that thinking is starting to give way.

An area that is "certainly a material risk to many companies," is climate change, he argued.

According to Mr. Hale, a recent analysis of the 4,000 companies in Sustainalytics' universe found roughly half of the companies face material financial risks in the transition to a low-carbon economy from a fossil-fuel based economy. (Morningstar Inc. is part owner of Sustainalytics, an ESG research company.)

Skepticism over the value of ESG investing is higher in the U.S. than the European Union or Canada, a survey of 434 institutional asset owners and consultants by
RBC Global Asset Management found. Half of U.S. investors surveyed in 2017 said they did not think taking an ESG approach to investment mitigated risk, while 23% said they were not sure. On the flip side, 77% of Europe-based investors and 68% of Canadian investors said they thought ESG mitigated risk. Additionally, only 17% of U.S. investors considered ESG as a source of alpha, compared with 22% in Canada and 51% in Europe.

Wooing younger workers

Mr. Bernhardt said several U.S. corporate DC plan sponsors and 403(b) plan sponsors that
Mercer works with are looking at adding ESG options to their lineups, a trend he expects to continue as more corporations embed sustainability considerations in their business plans.

Mark Wood, San Francisco-based vice president in
Callan's global research group, said he believes a desire among younger workers to have access to investment options that reflect their ethical and moral beliefs is driving DC plan sponsors to consider adding ESG funds.

Within the past year,
Callan conducted a couple of searches for corporate DC plans in "more traditional industries" that were looking to add an ESG option to their lineups based on "internal feedback from their employees and recognition from their investment board(s) that it's something they should address," Mr. Wood said. He declined to identify the clients.

Over the next year,
Mercer's Mr. Bernhardt expects to see more activity in thematic impact investing — strategies that try to achieve environmental or social outcomes alongside financial returns. He also expects to see more innovation in socially conscious strategies, and fixed-income and hedge fund ESG strategies, where innovation has lagged public equities.